Tradable and nontradable directed technical change

Seminari Applied

We wish to reconcile the major trends in wages and the terms of trade using a directed technical change approach in which: (i) tradable and nontradable goods can be substitutes or complements; and (ii) scale effects can be present or can be partially or totally removed. With a lower skilled labor ratio and a higher relative wage in the tradable sector, the price (real exchange rate or terms of trade) mechanism is crucial in determining sectoral productivity differences and thus wage inequality. Along the balanced growth path (BGP), the real exchange rate can be negatively related with the relative advantage to entry through horizontal innovation and with the relative labor level, de- pending on scale effects. The wage premium increases due to an increase in the relative labor level in the nontradable sector under substitutability with scale effects or under complementarity without scale effects. A calibrated version of the model indicates that the model replicates closely the data on wages for Germany. Moreover, as substitutability increases, the nontradable technological-knowledge bias, which drives wages, rises, while the nontradable relative price and nontradable value of knowledge decrease.